RUSSIA: OPPORTUNITY LAND

RUSSIA: OPPORTUNITY LAND

Russia now has such a bad reputation as a place to do business that one could be forgiven for wondering why any western company in its right mind would set up shop there. The short answer is that companies already invested in the country have been able to avoid corruption, work around the stifling bureaucracy and make money – far more than they could in most other developing economies.

True, the crisis over Ukraine could not have come at a worse time for the Russian economy. Last year's growth was only about one-third of the 3.4 per cent recorded in 2012. The country sorely needs to replenish its depleted infrastructure and industrial base, and that means it needs to restore the confidence of investors, domestic and foreign alike. Some observers believe that the latest round of geopolitical brinkmanship will set that task back by years.

But such gloomy prophesies have been made before, and each time they have proved incorrect – and expensive. Businesses and investors who retreated from Russia during previous crises missed the lucrative recoveries that followed.

One cause for optimism lies in the rise of Russia's middle class. By some measures, Russia is already Europe's second-biggest consumer market; with 144m people, it could eventually become the largest in Europe. Using the definition favoured by the OECD club of mostly rich nations, Russia's middle class encompasses more than half the population, compared with 30 per cent in Brazil, 21 per cent in China and 11 per cent in India.

The result is a growing market of affluent consumers. Between 2000 and 2012 retail spending in Russia grew at a compound rate of 20 per cent a year. The extraordinary boom in consumer spending has run its course; the growth rate was down to about 5 per cent last year. But the trend is clear. Russians are adopting the affluent lifestyles typical of people in developed economies.

Russia's rising middle class represents more than a commercial opportunity. Over time, it will remould the country's politics. Much has already changed over the past dozen years. Voters overwhelmingly support the absorption of Crimea into the Russian Federation, but polls also show a steady rise in concern over the state of the economy. Russia's people are growing used to travelling the world and spending their money. The Kremlin knows that the country's social and political stability depends on its ability to keep this growing section of the population in the lifestyle to which it is becoming accustomed.

Many commentators are sceptical that it can do so for long given the volatility of oil and gas prices, on which the government's finances are said to depend. It is true that oil and gas accounts for about two-thirds of Russian exports. But because of the steady expansion of the economy over the past decade, less than 50 per cent of tax revenue is generated from these industries.

The government learnt an expensive lesson in 2008, when the oil price collapse quickly eroded foreign exchange reserves and led to a budget deficit of 6 per cent of gross domestic product in 2009. If the oil price were to fall to $80 a barrel (it is currently about $100), the budget deficit would be 3 or 4 per cent. Given that Russia has public debt of only 11 per cent of GDP, such deficits could easily be sustained for several years. A gentle budgetary squeeze could give progressives in government additional leverage with which to drive through reforms.

The last phase of Russia's economic development was driven by a surge in consumer spending; the next will depend on investment. It is clear that for Russia to grow, it will need to attract more foreigners to do business in the country. That will be a lot more difficult than retaining those who are already making money there. The government is going to have to show real progress in combating corruption and streamlining the bureaucracy. It will also have to convince sceptical companies that the rule of law is strengthening, so that those who build assets in Russia can be confident of reaping the rewards.

None of this was going to be easy or quick, even before the Ukraine crisis prompted western sanctions and frayed investors' nerves. But despite the intrusion of politics and the risk of volatility in the oil market, Russia is still an attractive country in which to make money. International investors who are already there are staying, and others who join them stand to prosper.

Chronicle:

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